Back in early 2009, many economists seemed to move away from New Keynesian ideas, back to the so-called “vulgar Keynesianism” of the 1950s and 1960s. Recall that by the 1990s, the NKs accepted many ideas from the monetarists:

2. Wages and prices are flexible in the long run, and hence the economy eventually adjusts back to LRAS curve. Demand side policies only have a short-term impact on output.

3. Sluggish growth in productivity and/or the size of the labor force reflects structural problems, and cannot be remedied by demand stimulus (which can reduce high unemployment).

In 2009, economists like Paul Krugman assured us that the abandonment of NK orthodoxy was temporary, that “everything’s different” at the zero bound. Fiscal policy can be effective when the Fed is out of ammo.

I was skeptical that this would be temporary, and thus I’m not surprised that the old-style Keynesian revival has survived into the post-zero bound period. Here’s Alan Blinder in the WSJ:

Let’s look at some of the agreement’s main provisions. The budget for fiscal year 2016 and beyond blows through the spending caps put in place in 2013. (Remember the fiscal cliff and the sequester?) Furthermore, Congress extended more than 50 special tax breaks, often called “extenders,” without paying for them. So if your Christmas wish was further deficit reduction, you ended up with a lump of coal.

But the federal deficit that President Obama proposed for fiscal 2016 was merely 2.5% of GDP—a number in line with historical norms. There was no need to shrink it. Furthermore, with a still sluggish economy and the Federal Reserve beginning to raise interest rates, a little fiscal stimulus is welcome, even if the agreement provides very little. The big bucks in the budget deal come in the tax extenders, which everyone knew would be extended regardless. So making some of them permanent does not provide stimulus, nor does it really raise future deficits.

Blinder seems to defend some outrageous and inefficient (GOP) tax breaks, on the grounds that they provide fiscal stimulus. But how can that be? The inflation targeting Fed would simply raise rates more quickly, to prevent inflation from rising above their preferred target path (which calls for restoring 2% inflation in about 2 years.) Keynesians used to argue that monetary offset doesn’t hold at the zero bound. I don’t agree, but that’s a defensible argument. The current claims being made by Blinder don’t even seem defensible, or at least I’ve never seen a plausible defense. In any case, it’s now clear that Krugman was wrong; the end of the zero bound would not bring an end to calls for fiscal stimulus. Instead of “everything’s different” we find out that “nothing’s different.”

And Krugman himself seems to be jumping on the old Keynesian bandwagon, claiming that slow long-term growth reflects deficient demand, even though demand deficiencies would slow growth by raising the unemployment rate (in the Keynesian model), not by reducing productivity. And this claim is being made even though unemployment has fallen from 10% in 2009 to 5% today. Whatever this is, it’s not New Keynesian economics. It almost seems like economists have decided they want more fiscal stimulus, and then simply assume there must be a model that endorses their policy preferences.

You might complain that it’s unfair to tie Keynesians to the 1990s version of their model. Things change, and new hypotheses are dreamed up. Maybe there are mysterious “hysteresis effects” that allow demand stimulus to boost long-term growth. It didn’t work in Brazil, but hey, maybe it could work here. So shall we treat Krugman’s recent musings as an interesting new hypothesis, something to study and discuss? I’d be happy to, but Krugman himself won’t allow it. In a mind-boggling tone-deaf post he trashes Timothy Taylor (a moderate who supports fiscal stimulus during recessions). Here’s Taylor’s response:

Paul Krugman was “quite unhappy” with a paragraph in my blog post last Monday concerning “Secular Stagnation: An Update.” In his characteristic high-decibel mode, Paul manages in a single post to use the phrases “both wrong and, to some extent, cowardly,” “change the subject,” “actually engaged in an act of evasion,” “refusing to take sides is a dereliction of responsibility,” and more.

If that’s how he reacts to Taylor, I sure hope he never reads my posts. Unlike Taylor, I don’t even think that what Taylor calls the “2009-2012” fiscal stimulus helped, and can’t help noticing that GDP growth accelerated slightly immediately after it ended.

So Paul Krugman creates a new demand-side theory of secular stagnation, and then trashes the character of anyone who doesn’t immediately buy into his model. A model Krugman himself would have scoffed at in the 1990s. Indeed did scoff at, even a year after he had written his famous 1998 “Road to Damascus” revisionist model of the liquidity trap:

What continues to amaze me is this: Japan’s current strategy of massive, unsustainable deficit spending in the hopes that this will somehow generate a self-sustained recovery is currently regarded as the orthodox, sensible thing to do – even though it can be justified only by exotic stories about multiple equilibria, the sort of thing you would imagine only a professor could believe. Meanwhile further steps on monetary policy – the sort of thing you would advocate if you believed in a more conventional, boring model, one in which the problem is simply a question of the savings-investment balance – are rejected as dangerously radical and unbecoming of a dignified economy.

Will somebody please explain this to me?

So apparently the Paul Krugman of the 1980s and 1990s, the one who did research that later resulted in a Nobel Prize, was also a “cowardly” and “evasive” person who refused to take responsibility for demanding fiscal stimulus. Just like poor Timothy Taylor. Should the Nobel Prize be returned? Or was it awarded in anticipation of his later heterodoxy, just as President Obama’s 2009 Nobel Peace Prize was awarded for all the drone strikes, Libyan bombings, Syrian bombings, etc., that he was undoubtedly going toavoid doingduring his Presidency.

Sumner: “Blinder seems to defend some outrageous and inefficient (GOP) tax breaks, on the grounds that they provide fiscal stimulus. But how can that be? ” – well, Econ 101 says a tax break is the same as additional government spending. It’s kind of a “duh” point, but apparently over our host’s head. Y = C + I + G + (Ex-Im)

First, thanks for this post as I stopped following Krugman some time ago. And also thanks for reminding me how insane an economic debate is out there. Monetary policy unable to create demand literally three weeks after FED hiked interest rates which is their preferred way of thinking about monetary policy? What is this.

If I were state what changed for Krugman from the 1970/1980s to today is the Japanese economic experience. If the 1970s proved the old Keynesian can not explain everything than I would suggest the Japanese economy modified many Macroeconomic theories as well. I believe three things have changed:

1) When I doubt what is happening to the US economy, I simply think the labor market is slowly rewinding the 1970s labor market. (I think the primary problem the next 5 – 10 years is skilled working class positions at current wages is in short supply.)
2) Capital, especially IT capital, is very productive and this is decreasing the need for investment expenditures.
3) The world is peaceful outside of the Middle East and not blowing as much money on military as we have in the past. (This is another reason for decreased investment expenditures as well.)

The Nobel committee is filled with Bush hatred and their decisions have been influenced by this hatred…basically the award is a joke and Obama was unethical to even accept it. Obama should have told the committee to stick their “award” up their collective you know what…but Obama just has awful political instincts.

Fiscal stimulus has failed because the US is a very generous nation with a generous welfare system. So Obama and Pelosi attempted to use the welfare system for stimulus and the result was counterproductive spending that undermined the labor market. So SNAP for single mothers is actually productive government spending, Social Security to a 75 year old is productive spending, and so on and all of this spending is ongoing which means the most productive welfare spending was going on in 2008. So what we found out in 2009 is that the next welfare dollar spent ends up going to able bodied adults that should be working which ends up undermining the labor market.

fiscal stimulus will show up in this equation as an increase in V, but since the fed is responding to the right side of this equation, they will respond with a decrease in M to offset the increase in V. Paleo keynesians seem to have a difficult time understanding this.

Collin, with regard to 3 and I think we do Europe and Japan a huge disservice by taking on so much of the military burden of Europe and Japan. So Israel has a very strong economy along with a strong military. One thing militaries arguably do better than college is mold young men that can be very destructive to a society (at least our military does a better job than college of molding young men). Also military spending like that of Reagan has a very positive Keynesian multiplier for the overall economy.

So had Europe and Japan been rational actors they would have come to our aid once Iraq broke out in civil war after our invasion. I opposed the invasion but once we invaded the world needed Iraq to stabilize quickly and the world has suffered greatly due to the instability in Iraq. Don’t get me wrong, Bush mismanaged all aspects of the war including the diplomatic aspect but Trump is also correct in that invading Iraq was about helping the world and we got stuck with burden even though it should have been the entire West’s responsibility.

In fairness, a protracted period of inadequate aggregate demand, causing prolonged slack, could depress the level of business investment, including R&D. That could cause medium-term and even long-term shortfalls in productivity growth relative to trend. Businesses don’t invest much if they have idle capacity. They don’t try to buy labor-saving machinery if there is plenty of cheap labor available. Low interest rates don’t cause more investment; they reflect the lack of investment relative to saving.

This may be wrong, but it is not incoherent.

As for aggregate demand, we are wrapping up the 8th consecutive year in which nominal GDP has not increased more than 4.1%, well below pre-crisis trend. We still have slower aggregate demand growth. Do we need more deficit-spending to boost it?

In all fairness to Krugman, you (Prof Sumner) would also have objected to this passage in Tim Taylor’s original post (quoted by Krugman):

In the past, I have called this the problem of “snowbank macroeconomics:” just as a driver of a car stuck in a snowbank can press the gas pedal as hard as they want and not make much progress, it seems to me that we are in a situation where monetary and fiscal stimulus that has been extremely high by historical standards since about 2008 has had a much smaller effect on output and inflation than would have been expected before the Great Recession. I’ve come to believe that in a financial crisis and its slow-growth aftermath, the basic tools of monetary and fiscal policy face real limits on what they can accomplish.

Emphasis mine.

Except that while Krugman objects to calling fiscal stimulus “extremely high” since 2008, and he disagrees with the statement that the basic tools of fiscal policy face real limits in a financial crisis, you would object to calling monetary stimulus extremely high since 2008, and would disagree that monetary policy faces real limits in a financial crisis.

Collin, I think you missed the point. The Krugman quote was from 1999, after he wrote his famous 1999 paper on the Japanese liquidity trap. Now Krugman says Abenomics has increased inflation expectations in Japan. So what exactly has changed?

And Japan didn’t tell us anything we didn’t already know from the US in the 1930s.

Marcus, Yes, that’s possible. But unemployment is back to 5%, so I think the growth that we can expect from further demand stimulus is quite modest.

BB. I think that’s consistent with what I said in the post, isn’t it? However in my view the problems now are primarily supply-side, as unemployment is only 5%, and demand stimulus works by creating jobs.

Krugman is a liberal activist first and an economist second so his current economic opinions can be dismissed because his economic opinions are distorted by his politics. The fact he was a big critic of Bush that just happened to be a prominent economist is why he was given a Nobel Prize.

I am not sure what it is about our current society but one’s political classification often clouds one’s judgement on issues like economics or even science with politicized issues like climate change.

Monetary policy determines the path of the price of hamburgers, and thus counter-socialist policies like the free market are useless.

That’s Summer’s logic folks. If the central could in principle target the price or spending level of anything, it means any actual non-central bank attempts to determine those prices or spending levels are useless.

@BB i doubt that slack in resource utilization prevents investment. One couled easily make the argument that when there is no slack capital owners just keep extracting rents from their capital stock instead of choosing to innovate. When there is some slack, entreprreneurs have an incentive to reorganize capital and labor in more productive ways thus increasing productivity.

@Derivs – the formula Y = C + I + G + (Ex-Im) is policy agnostic, as it’s just an accounting identity. The old and new Keynesians think however there’s a “paradox of thrift” where the economy stops investing at times, that is broken by government spending, which according to their theory has a ‘multiplier’ (simple geometric series). Economics is full of such fallacies. The monetarists also believe in bogus shifting of the LS-IM curves due to two fallacies: (1) the central banks have a monopoly on money creation and ‘set’ interest rates (wrong: they follow the market), and, (2) credible short term changes in the money supply affect the real economy, due to wage and price stickiness (no evidence for this aside from misleading charts showing the wage curve is not perfectly symmetrical around the inflation rate).

@MF – Sumner is famous due to NGDPLT. Do you expect him to give up his fame just to concede a point to you? He’ll fight tooth-and-nail for his scheme, down to the bitter end, not unlike Saddam press spokesman “Baghdad Bob” in the Iraq war.

@Major.Freedom: I know you actually don’t care about macroeconomic theory, but your confusion here is pretty obvious. The free market sets relative prices, not absolute prices. Absolute prices (and hence NGDP) are a consequence of the value of the unit of account. With a fiat currency, that basically means the central bank’s arbitrary choice about the size of the money supply.

“Fiscal countercyclical policy” is a separate attempt to adjust NGDP. It is “useless”, because monetary policy is infinitely more powerful, and moves last. So NGDP will be whatever the central bank wants it to be, regardless of the choice of fiscal policy.

The free market’s discovery of relative prices, has nothing at all to do with the fiscal/monetary battle (easily won by the monetary side) for the absolute price level.

@Don Geddis – instead of just relying on your internet reputation, which is poor (and Sumner himself has corrected you when you’re wrong on monetarism), why not cut out the mystery writing and cite something to support your views? IS-LM btw is used by both Keynesians and monetarists, it’s pretty generic and largely uncontroversial, says I.

“And Krugman himself seems to be jumping on the old Keynesian bandwagon, claiming that slow long-term growth reflects deficient demand, even though demand deficiencies would slow growth by raising the unemployment rate (in the Keynesian model), not by reducing productivity. And this claim is being made even though unemployment has fallen from 10% in 2009 to 5% today. Whatever this is, it’s not New Keynesian economics. It almost seems like economists have decided they want more fiscal stimulus, and then simply assume there must be a model that endorses their policy preferences.”

Hysteresis. Inflation has been below target for years. Wages are stagnant, inequality is growing. Employment-population ratio is 58.5% rather than the trend 63%.

Demand is deficient until we see sustained wage growth and above target inflation.

I see monetary and fiscal policy as complimentary. Why the need to prioritize one over the other? Seem just like a political preference for smaller government. Krugman argues for more monetary AND fiscal policy, like he’s against the Fed’s decision to raise rates.

Peter K, The unemployment rate has fallen from 10% in 2009 to 5% today. I know of no macro model where that sort of change is associated with below trend growth. Sorry, but I just don’t believe it. I think “hysteresis” was dreamed up to explain the failure of the Keynesian model after 1975, especially in Europe.

Adrian, You said:

“My understanding is that NK models can produce positive effects of fiscal policy when at the zero bound”

We are not at the zero bound, so those models don’t apply. And no, being “close” to zero makes no difference; either policy is constrained or it isn’t.

You said:

“NK models can also produce secular stagnation under some conditions ”

Perhaps those models are now being created, but that was not the standard NK model before the recession.

So Paul Krugman creates a new demand-side theory of secular stagnation, and then trashes the character of anyone who doesn’t immediately buy into his model. A model Krugman himself would have scoffed at in the 1990s.

A simple hypothesis is staring you in the face: Robin. Wells. Writes. The. Column.

Dr. Krugman has, IIRC, placed about a baker’s dozen papers in professional and academic venues in the last eight years. A number of them are ‘reflections’ of the sort that are not ordinarily published and read like key-note addresses or after-dinner talks. Others are surveys of the sort which are ordinarily published as book chapters. One is an antique theoretical paper that he’d had sitting in a drawer for thirty-odd years. Only 3 or 4 were research papers, and he wasn’t the principal author on one of these. His schedule at CUNY consists of one course a term. He’s semi-retired.

Art, That’s sounds kind of like my career, except of course at a far lower level.

Seriously, I think he still writes them—it’s his “voice”.

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Welcome to a new blog on the endlessly perplexing problem of monetary policy. You’ll quickly notice that I am not a natural blogger, yet I feel compelled by recent events to give it a shot. Read more...

Bio

My name is Scott Sumner and I have taught economics at Bentley University for the past 27 years. I earned a BA in economics at Wisconsin and a PhD at Chicago. My research has been in the field of monetary economics, particularly the role of the gold standard in the Great Depression. I had just begun research on the relationship between cultural values and neoliberal reforms, when I got pulled back into monetary economics by the current crisis.